AD HOC EMERGING INVESTMENT MANAGER COMMITTEE. AGENDA Board of Fire and Police Pension Commissioners

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1 AD HOC EMERGING INVESTMENT MANAGER COMMITTEE AGENDA Board of Fire and Police Pension Commissioners George Aliano Carl Cade Emanuel Pleitez Belinda Vega FEBRUARY 6, :45 a.m. or Immediately Following the Regular Board Meeting Los Angeles Times Building 202 W. First Street, Suite 500 Los Angeles, CA An opportunity for the public to address the Board or Committee about any item on today s agenda for which there has been no previous opportunity for public comment will be provided before or during consideration of the item. Members of the public who wish to speak on any item on today s agenda are requested to complete a speaker card for each item they wish to address, and present the completed card(s) to the commission executive assistant. Speaker cards are available at the commission executive assistant s desk. In compliance with Government Code Section , non-exempt writings that are distributed to a majority or all of the Board or applicable Committee of the Board in advance of their meetings may be viewed at the office of the Los Angeles Fire and Police Pension System (LAFPP), located at 360 East 2 nd Street, 4 th Floor, Los Angeles, California 90012, or by clicking on LAFPP s website at or at the scheduled meeting. Non-exempt writings that are distributed to the Board or Committee at a scheduled meeting may be viewed at that meeting. In addition, if you would like a copy of any record related to an item on the agenda, please contact the commission executive assistant, at (213) or by at barbara.nobregas@lafpp.com. Sign language interpreters, communication access real-time transcription, assistive listening devices, or other auxiliary aids and/or services may be provided upon request. To ensure availability, you are advised to make your request at least 72 hours prior to the meeting you wish to attend. Due to difficulties in securing sign language interpreters, five or more business days notice is strongly recommended. For additional information, please contact the Department of Fire and Police Pensions, (213) voice or (213) TDD. 1. ELECTION OF CHAIR AND POSSIBLE COMMITTEE ACTION 2. DISCUSSION OF THE RESULTS OF THE DOMESTIC EQUITY MANAGER OF EMERGING MANAGERS SEARCH AND POSSIBLE COMMITTEE ACTION 3. DISCUSSION OF PRIOR AD HOC EMERGING INVESTMENT MANAGERS COMMITTEE REPORTS 4. PUBLIC COMMENTS

2 SPECIAL MEETING AGENDA Board of Fire and Police Pension Commissioners February 6, :45 a.m. or Immediately Following the Regular Board Meeting Los Angeles Times Building 202 W. First Street, Suite 500 Los Angeles, CA An opportunity for the public to address the Board or Committee about any item on today s agenda for which there has been no previous opportunity for public comment will be provided before or during consideration of the item. Members of the public who wish to speak on any item on today s agenda are requested to complete a speaker card for each item they wish to address, and present the completed card(s) to the commission executive assistant. Speaker cards are available at the commission executive assistant s desk. In compliance with Government Code Section , non-exempt writings that are distributed to a majority or all of the Board or applicable Committee of the Board in advance of their meetings may be viewed at the office of the Los Angeles Fire and Police Pension System (LAFPP), located at 360 East 2 nd Street, 4 th Floor, Los Angeles, California 90012, or by clicking on LAFPP s website at or at the scheduled meeting. Non-exempt writings that are distributed to the Board or Committee at a scheduled meeting may be viewed at that meeting. In addition, if you would like a copy of any record related to an item on the agenda, please contact the commission executive assistant, at (213) or by at barbara.nobregas@lafpp.com. Sign language interpreters, communication access real-time transcription, assistive listening devices, or other auxiliary aids and/or services may be provided upon request. To ensure availability, you are advised to make your request at least 72 hours prior to the meeting you wish to attend. Due to difficulties in securing sign language interpreters, five or more business days notice is strongly recommended. For additional information, please contact the Department of Fire and Police Pensions, (213) voice or (213) TDD. 1. ELECTION OF CHAIR AND POSSIBLE COMMITTEE ACTION 2. DISCUSSION OF THE RESULTS OF THE DOMESTIC EQUITY MANAGER OF EMERGING MANAGERS SEARCH AND POSSIBLE COMMITTEE ACTION 3. DISCUSSION OF PRIOR AD HOC EMERGING INVESTMENT MANAGERS COMMITTEE REPORTS 4. PUBLIC COMMENTS

3 DEPARTMENT OF FIRE AND POLICE PENSIONS 360 East Second Street, Suite 400 Los Angeles, CA (213) REPORT TO THE BOARD OF FIRE AND POLICE PENSION COMMISSIONERS REPORT TO THE AD HOC EMERGING INVESTMENT MANAGERS COMMITTEE January 16, 2014 February 6, 2014 ITEM: 2 FROM: SUBJECT: Raymond P. Ciranna, General Manager DISCUSSION OF THE RESULTS OF THE DOMESTIC EQUITY MANAGER OF EMERGING MANAGERS SEARCH AND POSSIBLE COMMITTEE ACTION RECOMMENDATIONS That the Committee review the results of the recent search for Managers of Emerging Managers and provide direction to Staff. BACKGROUND Emerging Managers The term Emerging Manager is defined in the Board s Emerging Manager Policy as independent investment management firms that manage less than $2 billion in firm-wide assets for any emerging manager retained directly by the Los Angeles Fire and Police Pension System. This quantitative-based definition can be modified by the Board as deemed appropriate for any particular Emerging Manager search. Some institutions define Emerging Manager as a minority or woman-owned firm. Such a definition is used by some public pension plans with Emerging Manager programs in other parts of the country. However, the passage of Proposition 209 in California in 1996 eliminated considerations of race, gender or ethnicity as allowable criteria in public contracting decisions. The Board s definition of Emerging Manager conforms to the requirements of the California State Constitution. The Emerging Manager Policy provides opportunities for managers who would normally be excluded from investment manager searches due to minimum size and experience criteria, but whose past performance might otherwise qualify them to manage money for the System. However, the hiring of Emerging Managers is conducted under the same principles that govern all other aspects of the Board s management of the Pension System to provide benefits to system participants to minimize City contributions; and, to defray the reasonable expenses of administering the system. In practice this means that when considering the hiring of an Emerging Manager, the Board needs to evaluate the manager s risk-adjusted returns net of fees and any other costs to the System, and determine whether there are other managers that can deliver comparable returns with less risk or expense.

4 Emerging Manager Program The Pension System s first Emerging Manager was hired in The formal Emerging Manager program began with the approval of the first Emerging Manager Policy in The Board has directly hired several Emerging Manager firms over the years to manage both equities and fixed income portfolios, and the program has also been extended to the Private Equity and the Real Estate asset classes. Two direct-hire firms have been managing securities for the System for over 10 years: Daruma Capital Management, LLC (small cap value equities hired in 1998) and LM Capital Group, LLC (opportunistic fixed income hired in 1997). Both firms have grown considerably since initially being hired by the Board, and due to their assets under management neither currently qualifies as an Emerging Manager. In 2013 the Board conducted a search for Emerging Managers as part of a search for International Equity managers, and hired Boston Common Asset Management, LLC and Del Rey Global Investors, LLC. Concerns with the level of success of the Emerging Manager program, and the amount of Board and Staff time required for its management, led in 2004 to the decision to consider utilizing the Manager of Emerging Managers model. In a Manager of Emerging Managers program (also known as a Fund of Funds program) the investor (the Pension System) hires a firm which then hires other firms (the underlying managers) to actually manage the System s account. Some of the advantages of this type of arrangement are that the Manager of Emerging Managers performs the due diligence on potential Emerging Managers, makes the hiring and termination decisions on the managers, and is responsible to the Pension System for the investment success of the account. One of the disadvantages is that fees are typically higher than what would be charged in a direct-hire program. This is because the manager hired by the Board earns a fee, from which that firm pays the fees of the underlying managers. Fees impact net investment returns and the higher the fees the more difficult it is for a fund of funds manager to consistently outperform the market or its peers. Attachment I is a presentation by the Board s General Consultant, RV Kuhns, on the differences between direct hire and the manager of managers model. Following a nation-wide search in 2004, the Board in early 2005 hired Manager of Emerging Manager firms Attucks Asset Management, LLC (Attucks) and FIS Group, Inc. (FIS). Attucks is managing a small cap domestic equity account and is benchmarked against the Russell 2000 index, while FIS is managing an all-cap domestic equity account and is benchmarked against the Russell 3000 index. The Request for Information In August 2012 the Board created an Ad Hoc Committee on Manager Fees to more closely review the Investment program s fee structures. Generally speaking, fees for passive (or index) managers are much cheaper than for active managers; fees charged for the most efficient and liquid asset classes (such as domestic large cap) are less than the fees charged for less efficient or illiquid asset classes (such as emerging market equities); and the larger the size of the account under management the lower the fee ratio charged by the manager. One of the areas of focus of the Ad Hoc Committee was the fees charged by the Managers of Emerging Managers. Attucks, managing a domestic small cap account of approximately $100 million through five underlying managers, has an expense ratio of 60 basis points. (One basis point is a hundredth of one percent; 60 basis points on $100 million is $600, ) FIS, managing a domestic all-cap account of approximately $175 million through eleven underlying managers, has an expense ratio of 46 basis points. Since being hired both Attucks and FIS have Board Report Page 2 February 6, 2014 January 16, 2014

5 provided inconsistent returns and are currently on the Board s Watch List. As a part of the Watch List process, Attucks and FIS made presentations to the Board in July At its meeting on May 2, 2013 the Board approved the Ad Hoc Managers Fees Committee s recommendation to issue a Request for Information (RFI) for domestic equity Managers of Emerging Managers. This recommendation was a result of the Committee s review of the performance and fee data from Attucks and FIS. An RFI would allow the Board to survey the current marketplace for Managers of Emerging Managers, and was a less-intensive exercise than a Request for Proposals (RFP). Staff and RV Kuhns, in accordance with the Board s approved search process for active managers, prepared a proposed list of minimum qualifications for managers responding to the RFI. The Board approved the minimum qualifications at the meeting of September 5, The minimum qualifications were: the firm must have been in business for at least one year as of September 1, 2013; the portfolio managers assigned to the LAFPP account must have a minimum of five years of experience in investment management; the investment strategy must have at least $200 million in assets under management as of September 1, 2013; and, the firm must have at least one tax-exempt account under management. The RFI consisted of 32 questions. The search opened on September 30, 2013 and closed on October 29, The search process included placing advertisements of the RFI in Pensions & Investments (P&I) Magazine and the P&I web site, and posting electronic versions of the RFI on the LAFPP web site and the Los Angeles Business Assistance Virtual Network (LA BAVN) web site. Staff also contacted each of the following organizations to make sure their members were aware of the RFI: New America Alliance (NAA), National Association of Securities Professionals (NASP), National Association of Investment Companies (NAIC) and the Association of Asian American Investment Managers (AAAIC) as well as the Emerging Manager Monthly magazine. Nine responses to the RFI were received. Attachment II provides summary information on each of the responding firms. Attachment III illustrates performance and fee data as provided by the firms. Attachment IV provides brief descriptions of each firm. DISCUSSION The nine firms responding to the RFI represent, in essence, the universe of firms offering Manager of Emerging Managers services to public fund institutional investors. Staff is familiar with many of the firms. Several made presentations to the Board in 2004 as part of the search process in which Attucks and FIS were hired. Most have visited the Investment Staff at various times over the years. Capital Prospects, Progress and Attucks manage money for LACERS under its Emerging Manager program (all three firms are currently on Watch at LACERS for underperformance). Acuitas is new to Staff. Acuitas does not meet the minimum criteria to qualify for the RFI, but its data is included in the Attachments to provide the Board with additional information on the Manager of Emerging Managers universe. The Board approved a search for Managers of Emerging Managers providing domestic equity products. Staff used the opportunity presented by the RFI to ask responding firms to provide information on all equity products they might offer. Some of the responding firms do provide nondomestic equity strategies; the information on those strategies is also included in the Attachments for the Board s information. Board Report Page 3 February 6, 2014 January 16, 2014

6 As can be seen from Attachment II, some of the firms are quite small with only a few employees and/or assets under management. A few are more established firms with substantial staffs and assets under management. The nine responding firms manage a total of six domestic equity strategies and three nondomestic equity strategies. Attachment III provides the returns and fee data for each investment strategy, with the applicable benchmark. Some firms offer several strategies and thus appear multiple times. Northern Trust chose to provide return data only on its non-domestic strategies, although the firm does offer domestic equity products. In all cases the returns represent each firm s composite account returns and are provided gross of fees. Reviewing the performance of the five firms offering a US all cap strategy, Capital Prospects is the only firm that beats the Russell 3000 benchmark in all time periods considered. However, adjusting Capital Prospects gross returns by deducting for fees, and it is probable that the firm would beat the benchmark in only the one-year time period. Leading Edge is the only firm offering US large cap core and US large cap growth strategies. Its reported returns in the core strategy, adjusted for fees, appear to exceed the returns of the Russell 1000 benchmark in three of the four time periods. Leading Edge s adjusted returns in the large cap growth strategy beat the Russell 1000 Growth benchmark in two of the four time periods considered. Progress is the only firm offering a product in the US mid cap space. The firm s returns, adjusted for fees, appear to exceed the Russell Mid-Cap benchmark over the three-year period, but not over the other three time periods. Six firms offer a US small cap strategy. All of the six have produced fee-adjusted returns in excess of the Russell 2000 benchmark over one or more of the four time periods considered. Acuitas is the only firm offering a micro cap strategy. The strategy is very new; it underperformed during calendar year 2012, but appears to have done well against the benchmark for the year ending September 30, Moving to the non-domestic space, Progress is the only firm offering an International developed markets strategy. Progress returns exceed the MSCI EAFE index in two of the four time periods. Three firms offer an ACWI ex-us product. Northern Trust s performance beats the benchmark over all time periods, while FIS and Leading Edge exceed the benchmark over three and two time periods, respectively. Finally, FIS and Legato offer a global product. Both firms fee-adjusted performance exceeds the benchmark in multiple time periods. CONCLUSIONS The Board wanted to survey the marketplace for Managers of Emerging Managers. The results of the RFI would seem to indicate that the few firms offering this service appear to offer broadly similar results. No one firm appears obviously superior to its competitors. Board Report Page 4 February 6, 2014 January 16, 2014

7 In the most efficient asset classes, such as large cap domestic equity, the ability of any active manager to consistently outperform a passive (index) manager is poor. The Board has been systematically shifting its large cap assets to index accounts, as its active large cap managers underperform and their contracts are either terminated or allowed to expire. The ability of the Managers of Emerging Managers to generate returns that exceed the benchmark appears to improve as the strategies move from the domestic large cap space to the less efficient and illiquid asset classes The Manager of Emerging Manager model is more expensive than directly hiring Emerging Managers. However, it may be that the time saved by the Board and Staff in reduced oversight responsibilities could perhaps justify the higher fees, in certain circumstances. Staff offers the following observations: The Board may determine that the Manager of Emerging Managers model is not effective, and decide to utilize only the direct hire model for the Emerging Managers program going forward. The contracts of the Board s current Managers of Emerging Managers, Attucks and FIS, will expire on June 30, 2015 and July 31, 2014, respectively. Both firms are currently on Watch. The next scheduled quarterly portfolio performance review will be presented to the Board by RV Kuhns in March of this year, during which calendar year performance for the prior year will be discussed. By Board Policy, Watch List determinations are made each year based on prior year calendar performance. The Board could decide to wait until the next portfolio performance report to make a decision on the current managers, and the Manager of Emerging Managers model. The Board may decide that the Manager of Emerging Managers model could provide better returns for the Pension System if it were refocused to the less efficient asset classes. Currently FIS manages a domestic all cap portfolio for the Board, while Attucks manages a domestic small cap portfolio. Changing an existing manager s mandate, or hiring new managers to manage a new mandate, has implications for the overall asset allocation of the Fund. The General Consultant should be asked to opine on any potential shift in Fund assets from the current asset allocation. The Board may disagree with Staff s assessment of the abilities of the firms responding to the RFI, and may decide that one or more of the firms have demonstrated the ability to consistently produce better returns than the Board s current Managers of Emerging Managers. In that case Staff could be requested to schedule the selected firm to make presentations before the Board, with the objective of new firms being approved to take over the mandate of an existing manager. This report was prepared by: Daren Perlstein Investment Officer RPC:TL:RR:PGP:DP Attachments: (I) Presentation by RV Kuhns dated December 2012 (II) Summary of Responses to Emerging Managers Request for Information (III) Manager of Emerging Managers Performance & Fee Comparisons (IV) Manager of Emerging Managers Firm Descriptions Board Report Page 5 February 6, 2014 January 16, 2014

8 DEPARTMENT OF FIRE AND POLICE PENSIONS 360 East Second Street, Suite 400 Los Angeles, CA (213) REPORT TO THE AD HOC EMERGING INVESTMENT MANAGERS COMMITTEE FEBRUARY 6, 2014 ITEM: 3 FROM: SUBJECT: Raymond P. Ciranna, General Manager DISCUSSION OF PRIOR AD HOC EMERGING INVESTMENT MANAGERS COMMITTEE REPORTS DISCUSSION The Ad Hoc Emerging Investment Managers first met on November 8, Since being formed the Committee has worked on a variety of issues relating to Emerging Managers (EM) including surveying other California Public Plans concerning their EM programs, updating the Fund s EM Policy and improving the Fund s outreach process. Attached is a series of EM-related reports presented to the Committee or Board over the past 18 months. This report was prepared by: Paul Palmer, Investment Officer RPC:TL:RR:PGP Attachments: (I) Emerging Manager Policies Consolidation (II) Emerging Manager Selection and Retention Policy Revisions (III) Emerging Manager Outreach Efforts (IV) Pros and Cons of Manager Fund of Funds vs Direct Investment (V) Discussion of Emerging Manager Search Processs (VI) Emerging Manager Survey Results